Sunday, 30 September 2007

When a Recession Threatens Cash Suddenly Has Cachet

by By Jonathan Clements

provided byWhen recession rules, cash is king.

It's tough to figure out where the economy is headed, and some folks think today's biggest risk is inflation, not recession. Still, in trimming the federal-funds rate last week, the Federal Reserve noted that "the tightening of credit conditions" could "restrain economic growth."

Indeed, the signs are ominous. August's jobs data were notably dismal, with nonfarm payrolls shrinking by 4,000, instead of the 112,000 job increase expected by Wall Street. Americans are getting squeezed by tumbling home prices, rising mortgage payments and $80-a-barrel oil, and all this could cut into consumer spending.

If the economy turns sluggish, it will be rough on those who lose their jobs, while offering buying opportunities to those still employed. But either way, there's one thing you'll want -- and that's access to cash.

• Taking advantage.

A mountain of cash would, of course, be a great comfort if you're laid off. But even if you hang on to your job, a little extra money in a high-yield savings account or a money-market fund could prove mighty useful.

Maybe a recession will further pummel the housing market, and you can put your savings toward buying a vacation home or trading up to a larger house. Maybe a slowing economy will knock shares lower, and you can use your cash to buy stocks at bargain prices.

For the cash-rich, a recession can also be a good time to purchase a car, as dealers slash prices to unload inventory. Alternatively, you might seize the chance to remodel the kitchen, knowing that contractors will likely bid more aggressively for your business.

• Reclaiming savings.

With all this in mind, stockpile savings.

But where? If you think your job is in jeopardy, forget funding the kid's college account and don't make extra-principal payments on your mortgage. The problem: If you lose your job, it may be hard to get your hands on this money.

You might also be tempted to skip your 401(k) plan. But in fact, sticking enough in your 401(k) to get your employer's full matching contribution should remain your top financial priority.

True, if you're laid off and strapped for cash, you might be forced to tap your 401(k), triggering income taxes and possibly tax penalties. That double whammy, however, will likely be more than offset by today's twin benefits, in the form of an initial tax deduction and the matching employer contribution.

After you have funded your 401(k), direct additional savings into a Roth individual retirement account. You can fully fund a Roth if you are single with income below $99,000 or married filing jointly with income under $156,000.

One of the Roth's little-known benefits: At any time, you can withdraw your contributions -- but not the account's investment earnings -- without paying taxes or penalties. That means this year's $4,000 Roth contribution could be next year's unemployment fund or next year's home-improvement fund.

Got additional money to save? Stuff it in a savings account or a money fund held in a regular taxable account. If you lose your job or buy a vacation home, this is the first place you should go for cash.

• Downsizing debt.

As you prep your finances for a possible recession, also get your debts under control.

Buy yourself some financial breathing room by paying off your credit cards. If you're worried you might get laid off, think twice before taking on new financial obligations, such as car leases and loans.

Also, set up a home-equity line of credit and check whether it's worth refinancing your mortgage to lower your monthly payments. You will likely find the mortgage company more receptive today, while you are still employed and still creditworthy.

If the economy slips into recession, and you lose your job or undertake major home improvements, the credit line could be a godsend. What if there's no recession? This extra borrowing power might still come in handy -- and you will no doubt find some use for all that extra cash you've saved.

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